One of the most common and important documents will be your income statement. Also called a profit and loss statement, this document provides you with a periodic summation of the profits and losses of the business during a specific time period, which may be one month, three months, six months or a year. The income statement, appropriately named, will provide you with an overall statement of your net income during the selected time period. It will prove advantageous for:
Paying taxes Evaluating your current financial position Making financial projections Attracting potential investors
The manner in which an income statement works is relatively simple. By listing both revenues and expenses, you can determine how much money you have earned. It is a simple formula in which you add up your revenues, add up your expenses and subtract the expenses from the revenues. (Revenues – Expenses = Net Income)
The Income Statement answers the question; “How is the business doing?” during a given time period. It allows you to see if you are spending too much money and if so, in which areas you could cut back. It also allows you to compare time frames such as the first quarter of 2004 versus the first quarter of 2003. This way you can compare your profits or losses and determine where you need to make adjustments. Your Income Statement should also help you determine your tax liability.
Typically, an Income Statement lists all revenue and expenses. The degree to which you breakdown each expense category will depend on the size and nature of the business along with the types of categories with which your business in most closely involved. For example, one business may have a general category for computer costs but a company in the technology industry, which relies heavily on the purchasing and maintenance of their computer system, might list specific items including; hardware costs, software costs, maintenance and repairs, and so on.
The Income Statement will typically include:
Total or gross sales. This sales figure shows the amount of revenue generated by the business from sales. Net sales. This is the total sales, less returns or refunds. Cost of goods sold. This includes all costs associated with manufacturing or acquiring the products you sell. In the service industry it is the cost of performing a specific service. Gross profit. This is the net sales, less the cost of goods sold. Operating expenses. This includes individual categories for employee salaries, payroll taxes, advertising, rent, office supplies, utilities, depreciation and all else necessary to operate the business. Operating profit. This shows you the difference between your gross profit and your operating expenses. Net income before taxes. Income taxes. Here you list the amount owed to the federal government. If you pay state or city taxes, include them here as well. Net income (after taxes).
The net income after taxes is your profit (or loss). By looking at your net income on periodic Income Statements, you can determine how the business is doing. If you are seeing steady losses you will need to make changes in operations or cut the costs of goods or services sold.
As part of your management of profit and loss — and overseeing the overall financial health of your business — you will also want to monitor your cash flow. Our plain-English guide to cash flow management tools explains how to look at those numbers, and it also tells you how to choose programs that will help you analyze them. Check out The Scoop on Cash Flow Management Tools now!